Sales Column

 

Understanding Cap Tables

 

By Brent Hawkins

 

Entrepreneurs are sometimes confused when a potential investor asks to see their "Cap Table." Many aren't exactly sure what a Capitalization Table (commonly called a Cap Table) is and, even if they do, they're not quite sure why an investor would want to see it. Others may not know exactly what a Cap Table should look like.

 

In short, a Cap Table shows who owns what stake in your company. It should show all shares that have been committed by your company to third parties (including those promised, gifted, optioned, accrued, etc.).

 

Key Issues and Considerations

So how should you model a Cap Table? Start with a Microsoft Excel spreadsheet. The math functions in a spreadsheet will serve you well by providing a mathematical cross check to your share numbers and facilitating updates to your Cap Table numbers as you add shares and shareholders. Then, with this foundation, ask yourself some basic questions about your capitalization plans and needs. Among them:

 

>>> Do you expect to raise money from investors soon? Try to model your capitalization structure so that your share price will be roughly $1. Why $1? That's what investors in our market expect. Is it a problem to have a share price different than that? Not at all, but why not lead with what investors expect? How, then, do you get to a price of $1 per share? Understand an investor's price formula: Price equals valuation divided by your fully diluted shares.

 

>>> How should you treat ownership between the founders? Typically the founder in a CEO role receives more stock than the others. Most investors like the CEOs of their companies to have at least a 10 percent stake on a post-financing basis so that the CEO is properly incentivized to make the company succeed. Founders in CTO or CFO roles are typically targeted at lesser percentages. But, there are more exceptions than rules here. Some founder groups like the egalitarianism of equal percentages and some founders may have more cash or intellectual property to contribute to the company than others, so should receive stock accordingly.

 

>>> Should there be some vesting among your founder group? You may be starting a company with a group of previously high-income, hard-charging young guns. That's good. But young guns accustomed to significant income may give up on your business plan if you do not find success quickly (and new companies rarely do). You may want to model your capitalization to allow for repurchase at an agreed price if a young gun leaves, as sort of "golden handcuffs" to keep them with the company. At the same time, note that vesting can sometimes trigger some unintended tax consequences that can be avoided in large part by making what is called an 83(b) election with the Internal Revenue Service.

 

What a Cap Table is Not

A Cap Table is a mere summary that relies on other documents — stock purchase agreements, option agreements and the like, which I will refer to as "issuance documents." If there is a discrepancy between a Cap Table and issuance documents, issuance documents will control. And there are a number of other actions and considerations that should go along with issuance documents. Your board of directors should approve all issuance documents. 

 

Do It Right the First Time

While modeling a Cap Table is not very hard, handling all of the issues and paperwork that goes along with it is. It is also expensive in terms of legal costs and drain on management's time and attention. So do it right the first time — it is hard to undo or change. Then, keep your Cap Table up to date as a resource to summarize what you've done.

Careful attention to your Cap table will professionally depict your equity issuances to investors and build their trust in you, even if they do not agree with all of your capitalization decisions and assessments. Best of luck!

 

Brent Hawkins, a partner at Salt Lake City-based Bennett Tueller Johnson & Deere P.C., regularly works with emerging and mid-size companies on issues relating to forming, financing, governance, strategic transactions, and mergers and acquisitions. Mr. Hawkins can be reached at bhawkins@btjd.com.

 

Launch - Fall & Winter 2008 (Special Print Edition)